Q: In a world of just two goods where all income is spent on the two goods, both goods cannot be inferior. True or False? Explain
True. In a world with just two goods where all income is spent, both goods cannot be inferior simultaneously.
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Here’s why:
Definitions:
- Inferior Goods: An inferior good is one for which demand decreases as consumer income increases. In other words, when income rises, people buy less of the inferior good and switch to more expensive alternatives.
Explanation:
If we have a scenario with just two goods, let’s call them Good X and Good Y. Suppose both goods are inferior:
- Demand Behavior: For Good X to be inferior, an increase in income would lead to a decrease in its consumption. Similarly, if Good Y is also inferior, an increase in income would also lead to a decrease in its consumption.
- Total Income Spending: The consumer spends all their income on these two goods. If both goods are inferior, then an increase in income would lead to a decrease in the consumption of both Good X and Good Y.
- Contradiction: If the consumer’s income increases and they spend less on both goods, they would have to allocate their budget differently, which is impossible if their total spending must equal their income. Essentially, if the consumer has more income, they would need to buy more of something, but both goods being inferior means they would buy less of both, creating a contradiction.
Conclusion:
In a scenario with only two goods, it is not feasible for both goods to be inferior because an increase in income would result in a decrease in consumption of both, which contradicts the notion of total income being spent on these goods. Therefore, at least one of the goods must be a normal good (where demand increases with income) to reconcile with the fact that all income is spent.